There has been a considerable focus on trade imbalances of late, as President Donald Trump has vociferously condemned the US’ bilateral trade deficits with trading partners, be they China or even US allies.
Although bilateral trade deficits are not inherently problematic, persistent trade deficits and a prolonged current account deficit could be. And whilst current account deficits have long been a focus of economists, what is less frequently mentioned are the problems arising from a sustained current account surplus. Surpluses can be the result of under-investment that could damage an economy in the long-run. There are a few discreet terms here, so before describing the potential consequences of a persistent current account surplus, it is worth noting the differences between trade deficits and current account deficits.
A trade deficit arises when a country exports less than it imports. The bilateral trade deficits that President Trump has excoriated are not a particularly useful metric for judging economic performance. Countries may buy more goods from one country (causing a deficit) and sell more to another (causing a surplus). As Scott Lincicome from the Cato Institute points out, ‘my bilateral deficit with my grocery store doesn’t tell you anything about whether I’m in debt’. Developed countries like the US or Australia often have a trade deficit in goods and a trade surplus in services as these economies move away from manufacturing and become more reliant on the provision of services, such as consultancy or education.
Beyond a purely bilateral deficit, a country will either have an aggregate trade deficit or surplus. Again, a deficit need not be bad. Deficits are often a reflection of a strong economy, as consumers spend more on imports and higher interest rates make foreigners more eager to invest; exchange rates will adjust accordingly tempering demand. What is interesting is that some countries have been able to maintain trade imbalances almost indefinitely. The US, for example, has long been able to maintain a trade deficit due to cheap borrowing.
The role of the US dollar in global financial transactions creates massive demand for US financial assets. This, in turn, allows the US to finance high consumption at a low cost creating a systematic imbalance. There is a tendency to view exports as good and imports as bad. However, what is important in terms of living standards is consumption. Exports allow countries to import and thereby benefit from higher consumption and the specialisation of production.
The current account reflects the imbalance of exports and imports as well as the difference between saving (both public and private) and investment. Countries like Australia and New Zealand have maintained current account deficits for decades which is not necessarily a problem if they are the result of productive investment. Similarly, deficits can be used to smooth-out sudden shocks in consumption (for instance due to natural disasters or drought) and are therefore a useful short-term tool. However, problems can arise from financial crises. During the Asian Financial Crisis that overtook Thailand in 1997, there was a sharp reduction in foreign financing, forcing Thailand to repay their debts and causing significant short-term pain.
So, whilst current account deficits are usually viewed negatively, they can, in fact, be beneficial. On the other hand, surpluses, which are generally considered to be good, can actually have pernicious effects. For instance, countries in Asia such as China often run current account surpluses. This is often due to a high rate of private saving (perhaps reflecting the lack of social security). In rich countries, such as Japan, it may reflect low levels of domestic demand and an aging population. Other countries such as Germany however, may suffer from chronic underinvestment. China itself earns far less on foreign investment abroad, in say US Treasury holdings, than it could if it productively invested that money at home.
For Germany, the excessive savings not only contribute to the unbalanced world trade that President Trump rails against, but it hurts Germany’s future. Low levels of public investment are compounded by low private investment. Critical infrastructure is not being built or repaired, depleting the countries capital stock.
There is a further worry about the global economy has a whole. High saving rates in some countries may lead to another financial crisis. Prior to the global financial crisis, unnaturally high levels of savings helped cause a global savings glut which in turn produced lower interest rates and reckless levels of borrowing. High savings also reduce global demand, hurting both deficit countries whose producers suffer less demand for their products as well as surplus countries whose consumers fail to benefit from more consumption.
Whilst China is trying to increase domestic consumption, there is a danger it will not. Japan is running a large budget deficit to stimulate domestic demand and negative interest rates (making savings lose value over time) but this has resulted in purchases of foreign assets abroad. Finally, in the Eurozone, interest rates cannot be adjusted individually for each country to make saving less profitable. There is a risk, therefore, that excessive surpluses will continue.
If the world is to overcome anaemic growth rates, it is necessary to focus not merely on the dangers posed by deficits, but by those imposed by excessive savings.
Jeremy Rees is the International Trade and Economy Fellow for Young Australians in International Affairs.